Bank of England deputy governor Sarah Breeden warned that hedge funds' growing influence in global bond markets could heighten the risk of a broader financial shock. Speaking to CNBC, Breeden highlighted the shift in bond market investors, noting that hedge funds have replaced traditional players like insurance companies and pension funds. These hedge funds often use leverage and are highly price-sensitive, increasing the likelihood of market turbulence spreading across borders.
The International Monetary Fund (IMF) echoed these concerns in its latest Global Financial Stability Report, acknowledging hedge funds' role in market liquidity but cautioning about their use of leverage and crowded trades. The IMF warned that these factors could amplify market stress during turbulent times, potentially impacting broader financial sectors, including banks' prime brokerage businesses.
Hedge funds now hold a record 7% of the $30 trillion U.S. Treasury market, according to data from the U.S. Office of Financial Research. Their presence has come under scrutiny following a sharp sell-off in sovereign debt and the use of so-called 'basis trades,' where hedge funds bet on price gaps between cash Treasurys and futures contracts, often with heavy leverage.
Recent market movements have underscored these risks. U.S. 10-year and 30-year Treasury yields hit their highest levels since 2002, while yields on U.K. gilts and France's OATs also reached multi-decade highs. Rising concerns about France's fiscal outlook have further fueled fears of a sovereign debt crisis in the euro zone.